Back in July, Morgan Stanley’s chief equity strategist wrote that in a year in which “rolling bear markets” across such assets as volatility, Italian bonds, Chinese stocks, commodities, emerging markets, only a handful of asset classes had remained unscathed: technology stocks, as well as discretionary and growth names. It was the reason why Wilson downgraded tech and growth names at the time.

And, until last week, Discretionary, Growth, and Tech had been among the last holdouts from this “rolling bear market” thesis. That all changed following two days of violent rotations within the market as tech stocks saw a 3.8% decline last week (and about twice that over the last two weeks) with the pain sharpest in Semiconductors. The Russell 1000 growth index plunged ~5% giving up nearly a third of its year to date gains. In addition to Growth stocks and small caps, Materials and Industrials performed very poorly as well and notably didn’t recover much during Friday’s session. Meanwhile, even though defensive areas were also hit, they were relative outperformers. In short, as Wilson writes in a Monday note, “the rolling bear finally got the last holdouts and in doing so did some pretty severe damage to the entire forest.”

Furthermore, while others are “running around trying to figure out what everyone else is doing and how much might still be for sale”, Wilson says that he is going to simply stick with the narrative he has had had all year:

… we are in the midst of a rolling bear market across all global risk assets caused by a drain in liquidity and peaking growth. While we have yet to see others adopt this narrative we are confident it is the right one. Therefore, it likely is not finished until it becomes more consensus thinking.

So, in order to decide if this move is over, we have to ask ourselves why rates shot up in the first place. While many were citing better economic data and inflation, we think the primary reason for the move higher was the widening US Treasury funding gap created by the Fed’s acceleration in its balance sheet reduction program (“Quantitative Tightening”) starting October 1st along with the ECB beginning to taper its Quantitative Easing program.

Throw in the blackout period for share buyback programs and its not difficult to see why we had a few accidents this month for risk assets.

And while various other commentators have suggested that the selling is over – including Morgan Stanley’s own quant desk – the problem as Wilson sees it is that “this liquidity issue is unlikely to get better before the end of the month when share buybacks resume in full force.”

Worse, the global liquidity issue is going to get worse as we move toward year end based on the Fed’s planned balance sheet reduction and ECB’s taper. The chart below shows the recent trajectory of global central bank balance sheet growth this year and Morgan Stanley’s projected path going forward.

As you can see, this balance sheet growth will go into negative territory by January and anytime we have see that in the past, it is typically not a happy time for risk assets.

Yet even despite the slide in multiples observed last week across most market sectors (except utilities), Growth, Discretionary, and Tech remain among the groups least impacted by the market wide derating this year (Exhibit 4). Energy, Materials, Financials, and Industrials have seen near 20% corrections in their multiples since the S&P’s valuation peak on December 18, the day before the tax bill was signed. And contrary to such financial stalwarts as JPM quant Marko Kolanovic, who last Friday was confident the market opportunity now is one where the dip is to be bought, Wilson does not think “the pain is over for Growth, Discretionary, and Tech and the rolling bear will likely be back for more.“

Reverting to the big picture, Wilson then writes that as global liquidity continues to shrink and as the “rolling bear markets” affect even formerly immune sectors, the absolute level of interest rates are the key difference between the selloff that happened during February and the one that happened this week. And while in February, rates were contained in the 2.70 – 2.90% range, the 10 year has now broken out above 3.10% and does not show signs of falling back to lower levels. What does that mean for valuation going forward? Wilson explains:

We like to think about valuation in the context of rates and the equity risk premium. The matrices shown in Exhibit 5 show the sensitivity to both. Assuming rates stay between 3.00 and 3.25, an equity risk premium of 300 to 325 puts us at a S&P multiple of 15 – 16.0x.

In short, 16.0x is now the ceiling for market multiples while it was the floor in February’s lower rate environment. If accurate, it would mean that as long as the 10Y traders between 3.00% and 3.50%, the S&P will remain range-bound between 2,580 and 2,900.